Cash Settlement and Price Discovery in Futures Markets

This paper examines how cash settlement affects the ability of the futures market to predict future spot prices. Adopting the G ew eke feedback measure, we find that the feeder cattle futures contract improved its price discovery function after the cash settlement was adopted in August 1986. Moreover, spot and futures markets became more integrated thereafter. We also consider the case in which the cash-settled lean hog futures contract replaced the physical delivery-settled live hog futures contract in December 1996. Herein the conclusion is drastically different. After cash settlement was adopted, the futures market was less effective in price discovery. Further, spot and futures markets were more segmented.